Insights into Editorial: Focus on simplifying the GST structure

On midnight of 1st July 2018, the biggest indirect taxation reform in the history of India, GST turned 1-year-old. These long 12 months have been a journey of lots of ups and downs and one can argue that not everything is as bright and shiny as the government wishes us to believe. GST simplified a slew of Indirect taxes with a unified tax and is expected to dramatically reshape India’s 2.4 trillion dollar economy.

The GST bill waited 17 long years before it was passed with a landslide majority votes in favour of it. Also, for the nationwide implementation of GST, a total of 33 GST Acts were passed accounting for 29 states, 2 UTs and 1 each for CGST and IGST.

Brief history: Birth of idea of GST:

The idea was proposed by the Atal Bihari Vajpayee government. The first Manmohan Singh government articulated the intent of implementing it from April 2010. However, the Constitution amendment Bill to enable the introduction of GST was introduced in March 2011. It could not be passed owing to a lack of political consensus and lapsed with the dissolution of the 15th Lok Sabha. The amendment was finally made in 2016.

Now that India has had the experience of running the GST system for a year, policymakers should focus on building on its successes and addressing its drawbacks to achieve its full potential.

GST invisible achievements: Analysis by Economic Survey:

Economists at the Union finance ministry studied GST data in detail and presented some interesting facts in this year’s Economic Survey.

First, the Survey showed that India’s formal non-farm payroll is much higher than is commonly believed. The implementation of the GST, which is bringing more businesses into the tax net, will further push formalization of the economy.

Second, the GST is leading to better tax compliance. The number of unique registrations has now crossed the 10 million mark, which is higher than entities registered in the pre-GST period, though they are not comparable as indirect taxpayers had to register multiple times in the earlier system. The increasing number of taxpayers and better compliance should help raise higher revenue in the medium to long run.

Third, the GST system is creating a vast repository of data that could be useful in policymaking. For example, it is now possible to know the state-wise distribution of international exports. This information can be used to fine tune policies in particular states to boost exports. Per capita gross state domestic product has a high correlation with exports.

Further, the way the GST Council has evolved is a notable achievement. All decisions so far have been taken by consensus. It shows the way complex issues can be addressed through cooperation between the Union and state governments. While the council has a specific purpose, perhaps the idea can be used to address policy issues in other areas.

How has GST impacted small businesses?

Small businesses now have to deal with only one department because all taxes have been subsumed under GST. This has reduced the level of compliance for small business. Their compliance cost is also saved.

Under GST, it is easy to take registration in different states directly through online portal from any place without any need to visit the department.

The availability of input tax credit has resulted in increased margins for small businesses. Input tax credit helps manufactures save on tax that they pay on output because they have already paid the same on their purchases. So, while paying tax on output, they can claim credit for the tax they paid on inputs.

Lacunae that needs to be addressed:

However, despite visible benefits, as has often been argued in these pages, the GST structure is far from optimum. The latest “India Development Update” of the World Bank, for example, noted that the 28% rate, applicable on a set of goods, is the second highest among the 115 countries sampled: 49 countries have a single rate and 28 have two rates. Only four countries other than India—Italy, Luxembourg, Pakistan and Ghana—have four rates.

It is important for India to simplify the tax structure. The first target should be to move to at least a three-rate structure, a lower rate for essential goods, a relatively high rate for luxury goods, and a standard rate for the majority of goods and services.

Presently, the GST regime has multiple tax slabs with five broad categories of zero, 5 per cent, 12 per cent, 18 per cent and 28 per cent. There are two more GST rates of 0.25 per cent for rough diamonds, precious stones and 3 per cent for gold, silver.

A Cess, ranging from 1 to 15 per cent, is levied on demerit and luxury goods over and above the highest rate of 28 per cent. The proceeds from the cess are intended to compensate state governments in the first five years of the GST regime for potential revenue losses after factoring in the projected revenue growth rate of 14 per cent with 2015-16 as the base year.

In this context, the outgoing chief economic adviser, Arvind Subramanian, has rightly noted that the 28% rate should go. Removing the highest 28 per cent slab and a uniform rate of cess should be the first step for further simplification of the Goods and Services Tax (GST).

Mr. Arvind Subramanian had headed a committee and submitted the report on the “Revenue Neutral Rate and Structure of Rates for the GST”. In his report, he had suggested a preferred revenue neutral rate of 15 per cent, with two, four, and six per cent rate for precious metals, a low rate of 12 per cent for goods along with a standard rate of 16.9, 17.3 and 17.7 per cent and one 40 per cent rate for demerit goods.

The GST Council can then work on further rationalization, though this would also depend on tax collection. On the basis of collections in nine months—showed that revenue went up by 11.9%, with implied tax buoyancy of 1.2. This was higher than the historical standard for indirect taxes.

Revenue is expected to increase further as some of the implementation issues are addressed with improvement in compliance. The ongoing recovery in economic activity should also help raise GST collections and open up space for rate rationalization, which will help remove distortions in the system.

Conclusion:

There is no denying the fact that any new taxation system in large country like India which has such a huge population with so many different cultural and political factors affecting it, would need at least 3-5 years to settle down. GST was the tax reform we had strived for and any new system would have certain teething issues. In fact, as per the latest World Bank report, ‘The Indian Goods and Services Tax (GST) system is among the most complex in the world with one of the highest tax rates.’

Apart from rates, some of the operational issues, such as those related to ease of filing and refund, need to be resolved. Delays in refund affect the working capital of firms and should be avoided, particularly in the case of exporters, in an environment of widening trade deficit. Further, the council will need to work on bringing items such as electricity, petroleum products and real estate into the GST net. This may not be easy; petroleum, for instance, contributes a significant chunk to state revenue. However, the inclusion of these items will make the system more robust and predictable.

Way forward:

Implementing GST was always going to be challenging given the breadth and depth of the economy. The information provided on the GST collections has been encouraging and, notwithstanding the operational issues, especially for the SMEs, the process has been quite smooth.

The major achievement has been in assimilating the unorganised segment progressively into the formal economy, which would be mutually beneficial in due course of time. There have been no serious complaints from the state on revenue shortfalls in the last year and the Union Budget was finally well balanced on the tax side. Therefore, it has been a fair enough success story.

As GST stabilizes and settles down, the council will need to continuously work on simplifying the structure to enable higher tax collection and economic growth.